A part of the market once considered a classic “Trump trade” has been left behind by investors, but they might want to reconsider, Bank of America said.
Enthusiasm for energy stocks has fizzled out among big investors, despite the president’s mantra of “drill, baby, drill.”
According to Bank of America, large-cap active mutual funds have reduced their energy holdings the most out of any sector in the past three months, and hedge funds are shorting energy more than any other S&P 500 sector. The downbeat views on energy follow a lackluster performance during Trump’s first term.
However, while institutional players flee the space, Bank of America sees an opportunity. The bank still sees plenty of upside and upgraded its rating to overweight in a note last month.
It’s not just the fact that institutional buyers may be nearing capitulation, though. Energy is a top performer in times of inflation and stagflation, thanks to the sector’s focus on cash dividends.
Bank of America pointed to the sector’s strong free cash flow generation as a sign that energy stocks are in good shape and can provide income to investors in times of rising prices.
The sector is also well insulated from tariffs compared to other parts of the market, as Bank of America believes energy companies would be largely exempt from protectionist trade policies.
Historically, the energy sector has been sensitive to oil prices, which could be a concern crude remains stuck in a rut. But since 2016, the energy sector’s sensitivity to oil has dropped by a third, which Bank of America attributes to the sector’s focus on distributing dividends. That means the sector will be shielded in a stagflationary scenario with lower growth and energy prices.
“If stagflation is the base case, Energy is more likely to outperform than underperform,” Savita Subramanian, head of US equity and quantitative strategy at the bank, wrote.
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